AIA's outlook turns negative after sovereign ratings: Moody’s

The sovereign rating actions will pressure AIA Co and AIA International's Aa2 IFSR because of the position of its ratings relative to the sovereign ratings of its key markets.

AIA’s outlook change to negative reflects the negative outlook on the sovereign ratings of China and Hong Kong, Moody's Investors Service reported. The sovereign rating actions will pressure AIA Co and AIA International's Aa2 IFSR because of the position of its ratings relative to the sovereign ratings of its key markets, which is already one notch higher than Hong Kong's government rating owing to its geographically diversified business and financial profiles.

Today's rating action also highlights AIA's business is exposed to the operating environment and economic conditions of China and Hong Kong. In terms of total assets and operating profit after tax (OPAT), the insurer's exposure to these two markets grew in 2022 to 49% and 57%, respectively, from 43% and 51% in 2019.

While AIA has only a small investment exposure to Hong Kong government bonds and its premiums written are mostly US dollar-denominated, the Hong Kong domestic market, together with the mainland Chinese visitor segment, contributed to a material share of premiums and earnings to the insurer.

In addition, mainland China has been the insurer's fastest-growing market in terms of value of new business (VONB) over the past five years, and the insurer's exposure to the Chinese government bonds accounted for 18% of its non-participating policyholder and shareholder investment portfolio as of 30 September.

As a result, AIA's key credit fundamentals are increasingly correlated with, and thus linked to, Hong Kong's and mainland China's economic and market conditions because of the financial and operational links that can exist.

The group reported 49% and 37% year-on-year growth in annualized new premiums and VONB, respectively, for the first half of 2023, underpinned by the rapid reopening of Asian markets after the coronavirus pandemic. 

All its reportable segments and distribution channels reported positive VONB growth. In particular, Hong Kong – the group's largest market, accounting for 31% of the group's VONB – reported 111% growth during this period. Mainland China, the group's second-largest market, recorded 14% VONB growth during the same period.

The insurer's underlying profitability has been steady and of high quality, supported by a high share of insurance and fee-based income, which accounted for 73% of its OPAT for 1H 2023. 

Furthermore, the profits were backed by geographically diversified markets, with a notably strong contribution from mainland China and Hong Kong, which together contributed over 50% of OPAT for 1H 2023.

In addition, the insurer also has a large profitable in-force book that generated a sizable contractual service margin (CSM) balance of around $50b, which represented future profits and would be gradually released as earnings.

The group's local capital summation method (LCSM) coverage ratio on a prescribed capital requirement basis (PCR) remained strong at 260% as of 30 June, compared with the minimum regulatory requirement of 100%. 

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The decline in the LCSM coverage ratio from 283% at the end 2022 was driven by the combined effects of a share buyback, higher regulatory capital requirements in certain markets and the temporary impact of intragroup capital movements.

The insurer has returned about $5.5b to shareholders via a share buyback as of 30 June since the commencement of the share buyback program in 2022. Nevertheless, the adverse impact on the group's financial flexibility and capital adequacy will be offset by the insurer's robust free surplus balance ($16b as of 30 June) and track record of strong net underlying free surplus generation. 

Nevertheless, a further material increase of shareholder returns, in terms of dividends or share buyback, could weaken the insurer's strong capitalisation.

AIA has maintained strong liquidity and access to capital markets, with its Moody's-adjusted financial leverage modest at 20.6% as of 30 June. This is despite a decline in the holding company's financial resources to $8.7b as of 30 June 2023 from $10.7 billion as of 31 December 2022 because of unrealized investment losses and higher shareholder returns due to share buyback.

The above strengths are counterbalanced by the higher operational risks and volatility stemming from some of AIA's operations being in less-developed countries. These operations have also led to its material exposure to government bonds in these jurisdictions, whose sovereign ratings are lowered compared to the insurer's IFSR.

Factors that may affect future performance

Given the negative outlook, the potential for an upgrade is limited. 

However, Moody's could return the outlook to stable if the rating outlooks for China and Hong Kong return to stable and the insurer's operating environments and the sovereign ratings of its other key markets significantly improve, while AIA maintains strong business and financial profiles.

Moody's could downgrade AIA's issuer and debt ratings if the IFSRs of AIA Co and AIA International are downgraded.

AIA Co and AIA International's IFSRs may be downgraded if: 1) Operating environments worsen, leading to downgrades in sovereign ratings of key markets; 2) Profits significantly decline, driven by weakened insurance demand or substantial investment losses, with a consistent return on capital below 8%; 3) Adjusted financial leverage surpasses 20% on a sustained basis; 4) Debt-heavy acquisitions or increased exposure to less-developed markets occur; or 5) Capital position deteriorates substantially due to volatile markets, changing interest rates, or a decline in capital generating capability.